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The Unintended Consequences of a Flatter Yield Curve

Posted November 21, 2017

Under Economic Issues, International Trade Issues

(Tim Duy – Bloomberg)

It was supposed to be easy. When the Federal Reserve started hiking the federal funds rate, longer-term interest rates would rise. After all, they were at very low levels, restrained by a low-term premium. The “Greenspan conundrum” of the past two cycles, when long rates failed to respond in line with higher short rates, couldn’t happen a third time in such circumstances.

But it didn’t work out that way. Short rates continue to gain on firming expectations of tighter Fed policy while long-rates stubbornly track sideways. As a result, the yield curve continues to flatten, raising fears of recession. What’s going on? Are the fears valid?

No, the yield curve does not yet signal recession. But it does suggest the economy remains mired in a low rate environment for the foreseeable future, which restricts the ability of the Fed to raise the federal funds rate. Click here to read more.